While small-cap stocks, such as Ensco plc (NYSE:ESV) with its market cap of USD $1.54B, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. The significance of doing due diligence on a company’s financial strength stems from the fact that over 20,000 companies go bankrupt in every quarter in the US alone. Here are few basic financial health checks to judge whether a company fits the bill or there is an additional risk which you should consider before taking the plunge. View our latest analysis for Ensco
Does ESV generate an acceptable amount of cash through operations?
Unxpected adverse events, such as natural disasters and wars, can be a true test of a company’s capacity to meet its obligations. Furthermore, failure to service debt can hurt its reputation, making funding expensive in the future. Fortunately, we can test the company’s capacity to pay back its debtholders without summoning any catastrophes by looking at how much cash it generates from its current operations. Last year, ESV’s operating cash flow was 0.08x its current debt. An annual operating cash flow of less than a tenth of the overall debt raises red flags, although short-term obstacles and business cyclicality may temporarily impact ESV’s ability to generate cash.
Does ESV’s liquid assets cover its short-term commitments?
What about its other commitments such as payments to suppliers and salaries to its employees? As cash flow from operation is hindered by adverse events, ESV may need to liquidate its short-term assets to meet these upcoming payments. We test for ESV’s ability to meet these needs by comparing its cash and short-term investments with current liabilities. Our analysis shows that ESV is able to meet its upcoming commitments with its cash and other short-term assets, which lessens our concerns for the company’s business operations should any unfavourable circumstances arise.
Is ESV’s level of debt at an acceptable level?
Debt-to-equity ratio tells us how much of the asset debtors could claim if the company went out of business. ESV’s debt-to-equity ratio stands at 57.93%, which means, while the company’s debt could pose a problem for its earnings stability, it is not at an alarmingly high level yet. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings at least three times its interest payments is considered financially sound. In ESV’s case, its interest is not sufficiently covered by its profits as the ratio is 1.44x. Debtors may be less inclined to loan the company more money, giving ESV less headroom for growth through debt.
Are you a shareholder? ESV’s debt and cash flow levels indicate room for improvement. Its cash flow coverage of less than a quarter of debt means that operating efficiency could be an issue. However, the company exhibits an ability to meet its near term obligations should an adverse event occur. Given that its financial position may be different. I recommend researching market expectations for ESV’s future growth on our free analysis platform.
Are you a potential investor? Though short-term liquidity isn’t an issue, ESV’s large debt ratio on top of poor cash coverage may send potential investors running the other way. But, keep in mind that this is a point-in-time analysis, and today’s performance may not be representative of ESV’s track record. You should continue your analysis by taking a look at ESV’s past performance analysis on our free platform in order to determine for yourself whether its debt position is justified.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.